3.1.2 Business growth Flashcards

1
Q

Why do businesses want to grow?

A

Firms usually grow to increase their profit, which can be achieved by:
- Increasing economies of scale
- Increasing market share and reducing competition
- Expanding into new markets

However, firms may also want to grow due to:
- Product diversification
- Status of running a large firm
- Easier access to finance

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2
Q

Circumstances encouraging business growth

A
  • A gap in the market created by changing consumer tastes and technology.
  • Finance - Business growth can be financed by a parent company (cross-subsidisation).
  • If barriers of entry can be put in place by a firm. For example, if a firm can secure a patent quickly.
  • If a firm was able to ‘make the first move’, then economies of scale create a barrier to entry.
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3
Q

Circumstances preventing business growth

A
  • Poor management
  • Lack of finances to meet demand
  • Small market without the ability to reach economies of scale
  • Nature of the business means that small, close customer
    service is more effective – inability to ‘scale-up’ the business.
  • CMA may block a takeover or merger.
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4
Q

Organic growth (and an example)

A

Where a firm’s market share is increased by reinvesting profits, innovation, improving productivity and launching products into new markets.

For example, increasing output by building a larger factory, hiring more workers, and increasing the amount of raw materials used.

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5
Q

Advantages of organic growth

A
  • The firm has control over exactly how this growth occurs.
  • Can be financed by retained profits.
  • Builds upon a business’ strengths.
  • Allows the business to grow at a more sustainable rate.
  • More likely to be able to monitor and avoid the principal-agent problem.
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6
Q

Disadvantages of organic growth

A
  • Tends to be slow.
  • Can be more expensive.
  • Growth achieved may be dependent on the growth of the overall market.
  • Harder to build market share if business is already a leader.
  • Slow growth – cannot progress without retained profit or borrowing.
  • Rivals may opt for M&As and grow more quickly … could even buy your firm!
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7
Q

Inorganic growth

A

Where a firm’s market share is increased as a result of takeovers and mergers.

Instead of trying to defeat rival firms, inorganic growth involves purchasing rivals. Although competition authorities (such as the CMA) can block mergers and acquisitions.

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8
Q

Takeover

A

When one firm buys another firm, which becomes part of the first firm.

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9
Q

Merger

A

When two firms unite to form a new company.

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10
Q

Advantages of inorganic growth

A
  • Quicker than organic growth.
  • Cheaper than organic growth.
  • Easy way to gain experience and expertise in a new area of business.
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11
Q

Disadvantage of inorganic growth

A

Competition authorities (such as the CMA) can block mergers and acquisitions.

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12
Q

Horizontal integration

A

Mergers take place between companies at the same stage of the production chain.

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13
Q

Advantages of horizontal integration

A
  • Larger market share
  • Larger base of customers
  • Increased revenue
  • Reduced competition
  • Increasing synergies
  • Economies of scale
  • Reduced production costs
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14
Q

Disadvantages of horizontal integration

A
  • Reduced economic growth
  • Regulatory scrutiny
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15
Q

Real-life examples of Horizontal Integration

A
  • Disney purchased Pixar (both animation studios).
  • Morrisons and Safeway in 2004 (both supermarkets).
  • Nike and Umbro (both sports brands).
  • Iberia and British Airways (both airlines).
  • Orange and T-Mobile (both phone network providers).
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16
Q

Vertical integration

A

Firm merges with another company that is involved in a different stage of the production process.

17
Q

Forwards vertical integration

A

When a firm takes over another firm that is further forward in the production process (closer to the consumer). E.g. Cadbury buying a chocolate shop.

18
Q

Backwards vertical integration

A

When a firm takes over another firm that is further back in the production process (closer to the raw materials). E.g. Cadbury buying a cocoa farm.

19
Q

Advantages of vertical integration

A
  • Economies of scale
  • Expands geographically
  • Efficiency
  • Differentiate from competitors
  • Securing a supply chain
20
Q

Disadvantages of vertical integration

A
  • Established distribution channels may be affected
  • Could lead to a monopsony
21
Q

Real-life example of vertical integration

A

Apple purchased a chip-manufacturing company (backwards) and opening up retail stores (forwards).

22
Q

Conglomerate merger

A

Firms from different industries merge. E.g. Ford and a dairy farm.

Conglomerate mergers allow firms to diversify and spread their risk – if one part of the new firm does badly, this can be compensated for by profit from another part of the firm.
A conglomerate merger will also allow a firm to use profits generated by one product to invest in another.

23
Q

Advantages of conglomerate merger

A
  • Gain synergies
  • Diversification
  • Improves customer base
  • Economies of scale
24
Q

Disadvantages of conglomerate merger

A
  • No past experience
  • Shift in focus
  • Diseconomies of scale
25
Q

Real-life examples of conglomerate merger

A
  • Amazon purchased Whole Foods (a US supermarket company).
  • Virgin – with Media, Airlines, Banking
  • Co-operative group – with Food, Banking, Funerals
  • Unilever
26
Q

Disadvantages of growth

A
  • If two firms merge there will be a duplication of staff, such as marketing, finance and HR. It’s therefore likely that some of this staff will be made redundant.
  • The merged firms may have different or incompatible objectives that will need to be resolved
  • A firm can put itself in a lot of debt in order to raise the finance necessary to complete a takeover.
  • The new, larger firm may suffer from diseconomies of scale.
27
Q

Benefits of business growth on consumers

A
  • A larger firm may benefit from economies of scale which could lead to price reductions for consumers.
  • The combined creativity of two firms working together may lead to the production of better quality products.
28
Q

Negatives of business growth on consumers

A
  • Consumers will have less choice if two or more firms merge.
  • The reduction in competition caused by firms merging may also lead to higher prices for consumers.
  • Two merged firms may produce less output than two separate firms, which will lead to price increases.
29
Q

How do governments monitor mergers?

A

Typically via a competition authority (the CMA in the UK).

For example, a merger can lead to the creation of a monopoly, which will have advantages and disadvantages for consumers. If a government decides that a merger is unfair to consumers, then it can take action to block the merger.

30
Q

Reasons for mergers/takeovers

A
  • Increase market share
  • Spread risk
  • Lower costs of production (through economies of scale)
  • Eliminate competition
  • To acquire tangible (e.g. infrastructure) and intangible (e.g patents) assets
  • To acquire a new customer base
  • Quick expansion of firm
  • Access to new market
  • Overcoming barriers to entry
  • Increase profits
  • To create synergies
31
Q

Tangible assets

A

Physical assets e.g. Labour, machines, buildings

32
Q

Intangible assets

A

Not physical assets. E.g. Distribution rights, trademarks and patents.

33
Q

Synergy

A

“Whole is greater than the sum of its parts”.

  • When workers, firms and other economic agents work together effectively, synergy is created. This leads to innovation and higher productivity (than if they were apart). | If a merger is successful, it can bring synergy to both firms.